Political chaos in the European Monetary System and massive sales of dollars by nervous investors sent the foreign exchange markets into turmoil for a second day yesterday, taking shares and bonds sharply down.
The US currency continued to fall, despite a record $5bn bout of intervention by the Bank of Japan.
The FT-SE 100 share price index in London had at one stage fallen more than 50 points, while a near-40-point drop in the Dow Jones index on Wall Street was trimmed only after upbeat economic statements from Alan Greenspan, chairman of the Federal Reserve.
The dollar revived briefly to 103 in Tokyo but fell later. It also declined against the mark which strengthened once more against the traditionally weak European currencies, despite intervention by the central banks of Italy, Spain and Portugal. But it steadied against the Swiss franc following its unprecedented recent plunge.
The dramatic currency swings were triggered by a series of events earlier this week. A record US trade deficit, disappointment with Japan's emergency budget, and remarks by Theo Waigel, German Finance Minister, about Italy's dim chances of taking part in the single European currency all contributed.
The currency turbulence sent US bonds and shares heading sharply lower - followed by other stock markets - until testimony by Mr Greenspan restored some calm. Mr Green- span said the inflation picture had become more favourable and short- term prospects for the US economy had improved since early this year.
Financial markets are expected to remain unsettled for some time, although few analysts yesterday viewed this latest episode of turmoil as a definite crisis. The strains are so far not as great as in the last European currency upset, in February and March.
Sir Alan Walters, a noted Euro-sceptic and adviser to Baroness Thatcher, said: "This is just the sort of event one would expect in Europe but the single currency project will limp on. Nobody wants to take responsibility for dooming it."
William Dudley, a senior economist at investment bank Goldman Sachs, said: "This is more a correction than a sustained sell-off of the weak currencies."
However, the foreign exchange market could remain unsettled for some time in the absence of co-ordinated intervention by the American, German and Japanese central banks. Robin Marshall, chief economist at Chase Manhattan in London said: "The markets will remain fairly lively, although I think the central banks will stay in control as long as they speak with one voice."
Prospects for share prices will depend on the currency markets. Mark Brown, chief strategist at Hoare Govett, said: "This is a nervous correction in markets that have been doing very well." Nick Knight, Nomura's strategist, was gloomier. "This could turn out to be a pivotal week for equities," he said.
The dollar was down to 99.10 by the close from 99.15 at midday in New York. It had slipped to DM1.4132 from DM1.4237 at the previous close. The Dow Jones index opened more than 30down but closed just 3.25 lower at 4,764.15.
The mark rose a little to 1.2441 to the Swiss franc. Sterling was caught in the crosswinds. Its index against a range of other currencies closed only 0.1 lower at 84.5.Reuse content